Historically, the Value of Gold Always Rises During a Financial Crisis – Gregory Reynolds

When in the midst of a perfect hurricane that is threatening the world’s financial structure, it helps to remember an old adage – To know where you are going, look back to where you have been.

The era that should be examined is the Great Depression which began in 1929 with many similar events to what happened in the past few months. It didn’t officially end until 1939 when the world plunged into the Second World War but the reality is that the worst ended in 1934.

The slow climb to normality took six years but it could be seen and measured.

The single most important step taken by the United States, then as now a world power, was the decision on Jan. 31, 1934 to raise the price of gold from US$20.67 an ounce to $35 an ounce.

As president of the United States, Franklin Delano Roosevelt surveyed the wreckage of the U.S. banking system and decided drastic action was required. On March 6, 1933 he closed all the banks for a three day holiday.

He did this because frightened investors were going to banks and demanding gold and dollars but too many wanted the metal over the paper currency.

Under the gold standard a currency is backed by a nation’s gold stocks.

Any U.S. citizen could go to a bank and exchange $20.67 for an ounce of gold. That action failed to stop depositors making runs on their neighbourhood banks. So did a number of economic actions he took during the following weeks.

He then announced on April 19 that he was taking the nation off the gold standard. This action has been decried by historians, and some financial experts, for many decades.

Gold bugs, those who believe the whole world should be on the gold standard, have been unhappy ever since that event but this planet owes a vote of thanks to the man responsible.

Raising the price of gold by 75 per cent not only increased the value of the U.S. monetary reserves but those of every nation holding bullion. Thus, governments were able to increase their money supplies and infuse credit into their financial systems.

Four years into the depression, the entire U.S. banking system was in danger of collapse. FDR realized he had to take drastic action because people still wanted gold over paper so he passed the Gold Reserve Act on Jan.30, 1934.

This act did three things – it established the Exchange Stabilization Fund, allowed the U.S. Treasury to size all gold held by Federal Reserve banks and private possession of gold was made illegal.

In 1930, some 1,350 banks closed because people wanted their money or gold and small banks couldn’t meet demand. Privately owned banks were then, and now, allowed in America. The failed number was 2,293 in 1931, in 1932 it was 1,493 and about 4,000 in 1933.

There were none in 1934 because citizens had no choice but to use paper currency and therefore faith was restored in the U.S. economy.

Such a big jump in the price stimulated the world’s gold industry, in particular Canada’s. There were two new gold mines opened in Canada in 1934, as ore reserves that were uneconomical at $15 an ounce became profitable at $35. In the next six years, 1934-39, there were a further 39 mines opened.

FDR didn’t forget silver, mined both alone and in association with gold deposits. Silver hit rock bottom in 1932 when it sold for 24.5 cents an ounce in New York.

On June 19, 1934 he passed the Silver Purchase Act, empowering the president to increase the Treasury’s silver holdings to one-third the value of gold in its vaults. The act also nationalized silver supplies and purchases. The following year, FDR ordered the Treasury to start buying domestically produced silver at 77.57 cents an ounce.

Both actions regarding gold and silver proven vital in assisting other nations to climb out of the depression. That they did it on the back of the U.S. was unimportant.

In her book on FDR, The Forgotten Man: A New History of the Great Depression, Amity Shlaes makes the point that FDR came to office on March 4, 1933 without a plan but was determined to use his political capital to experiment with policy in an effort to end the depression. She says two distinct themes emerged.

First, FDR felt the need to be doing something so as to let people know that their government cared and was marshalling as many resources as it could to help them. Second, FDR believed that what was needed to be done was to centralize economic regulation within the federal government.

He quickly adopted the Keynesian philosophy that governments run deficits in bad time in order to stimulate the economy and build surpluses during good times.

British economist John Maynard Keynes wrote his Treatise on Money in 1930 and to this day his theories provoke heated discussions in economic circles but FDR believed in them.

Keynes advanced two basic principles to be followed in poor economic times – a reduction in interest rates and government investment in infrastructure.

The injection of income results in more spending in the general economy, which in turn stimulates more production and investment involving still more income and spending and so forth. The initial stimulation starts a cascade of events, whose total increase in economic activity is a multiple of the original investment.

Massive public works projects were undertaken in almost every part of the U.S., putting money into the hands of ordinary people. Author Shlaes claims Roosevelt set the daily (domestic) price of gold while having his breakfast, based on nothing more than a hunch.

Even if it is true, was this procedure any more scientific than having five men talk on the telephone in London, England and twice a day fix the world spot price of gold?

That FDR changed the fundamentals of government’s role in the economy altered the world as it existed in the 1930s is history.

What is happening to the world today, suffering through losses in stock values and production running into trillions of dollars, will lead to change that cannot be predicted today but must, and will, occur.

Economist Richard M. Salsman in an interview with Capitalism Magazine in 1999 saw gold differently from gold bugs. He rejected the idea that gold sales by central banks causes its price to fall.

He said “the gold price isn’t falling because central banks are selling; central banks are selling because the gold price has been falling. “Whenever the gold price falls, in any currency, it makes sense to buy financial assets. Stock and bonds tend to move inversely with the gold price.”

He also advances the argument that “total gold stock raise every year – and never falls – because unlike other commodities (excepting silver), gold is produced for purposes of accumulation, not consumption. “And it’s held not for industrial use but primarily as a hedge against inflation or it’s held less when there’s deflation.”

Barrick Gold Corp owns the world’s largest gold reserves and its chair Peter Monk said on Sept.25 that the U.S. government’s trillion dollar plus bailout of the credit markets will erode the value of its dollar and support gold prices.

When nations run their printing presses full blast and flood their economies with paper money, inflation is created.

History tells us one thing is certain in the present financial crisis – gold will climb in value.

Gregory Reynolds is a Timmins, Canada-based columnist who writes extensively about mining and northern Ontario issues

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